Reinier advises national and international companies
reinier.russell@russell.nl +31 20 301 55 55When is a director still permitted to participate in decision-making if they have a personal conflict of interest regarding a decision? And who is authorised to make that judgement?
Within companies, it can happen that directors are not entirely ‘neutral’. For example, they may also be shareholders, have ties to the other party, or have a financial interest in a transaction in some other way. That is not prohibited in itself. The line is crossed when that personal interest conflicts with the interests of the company.
A conflict of interest arises when a director is faced with such incompatible interests that there is reasonable doubt as to whether he is guided exclusively by the interests of the company in his actions. This does not only concern situations in which the director is the other party themselves; an indirect personal interest, or an interest via a third party with whom the director is closely connected, may also suffice. This is the case, for example, when it concerns the interest of a partner or a child.
The test is objective: what matters is not what the director themselves thinks, but whether an outsider would reasonably doubt their independence. Furthermore, it is not required that the conflict of interest has actually led to an incorrect decision. The mere existence of the conflict of interest may be sufficient to exclude the director from participating in the decision-making process.
However, not every personal interest automatically constitutes a conflict of interest. There must be a concrete tension between the personal interest and the company’s interest. The mere fact that a director is also a shareholder or, may derive an indirect economic benefit from a particular decision, is insufficient for this. Only if that tension is sufficiently concrete can it reasonably be doubted whether the director can still act independently.
A recent ruling by the Supreme Court clarifies who is authorised to determine whether there is a conflict of interest.
This case centred on flash delivery service Getir, an internationally operating company that continued to make losses despite previous financing. The largest financier had by then provided hundreds of millions in credit and made it a condition for further financing that all shares held by Getir in its Turkish operations and other subsidiaries be transferred to the financier in exchange for debt forgiveness. This would have prevented bankruptcy.
The company’s founders, who were also non-executive directors, did not wish to agree to this. They had previously made arrangements regarding a different restructuring of the group, from which they themselves could derive rights. Accepting the financier’s proposal would have definitively thwarted those agreements. Consequently, they had a personal interest in rejecting the transaction, an interest that was at odds with what the company might have needed to avoid bankruptcy. The executive directors therefore took the relevant decisions on the matter without them. The founders challenged this before the Enterprise Chamber and subsequently before the Supreme Court.
The central question in the judgment is: who decides whether a director has a conflict of interest: the director concerned himself, or his fellow directors?
The Supreme Court is clear: it is not for the director concerned to judge this himself. In the event of a difference of opinion, it is for the other directors to decide whether the director concerned should be excluded from the deliberations and decision-making due to a conflict of interest. Once they have reached that conclusion, they must also ensure that the director concerned is actually excluded.
However, the director concerned does have an active duty to disclose: he must exercise the greatest possible transparency and make his potential conflict of interest known to his fellow directors. But if he has failed to do so, this does not alter the other directors’ power to intervene at a later stage.
If there is a conflict of interest, the other directors take the decision. If they are unable to do so because they too have a conflict of interest, or if there are no other directors, decision-making shifts to the supervisory board. If there is no supervisory board, or if the supervisory board members also have a conflict of interest, the general meeting of shareholders must take the decision, unless the articles of association provide otherwise.
The rules on conflicts of interest are primarily aimed at internal relations within the company. The aim is to ensure careful and ethical decision-making, not to protect the interests of third parties. A decision in which a director with a conflict of interest was involved is therefore not automatically invalid vis-à-vis third parties, whether they have suffered a disadvantage as a result of the decision or have, on the contrary, benefited from it. The consequences are mainly internal.
Where things often go wrong in practice is when considering what happens if a director wrongfully participates in the decision-making process. This is primarily a matter of internal liability. The director may be held liable if he can be seriously blamed and the company has suffered damage.
The following factors, among others, play a role in this:
In particular, a lack of transparency works to the director’s disadvantage.
The Supreme Court’s ruling makes it clear that fellow directors not only have the right but, also bear the responsibility to intervene when they believe that a fellow director should not participate in the decision-making process due to a conflict of interest. The director concerned has no decisive say in this matter regarding his own position.
Directors would be wise to identify potential conflicts of interest at an early stage and make them explicitly open for discussion. Cases of doubt should not be ignored but carefully documented and assessed. It is advisable for companies to establish clear internal agreements on how to deal with such situations, with fixed procedures for reporting, assessing and documenting conflicts of interest.
Issues surrounding conflicts of interest often arise in complex decision-making situations and can have consequences for internal relations within the company and the position of directors. Do you have any questions regarding this blog or would you like advice on a specific situation? Please contact us.
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